Abercrombie & Fitch's Upside Surprise

Abercrombie & Fitch's most recent earnings were a pleasant surprise, showing that teen-fashion retailers may be in a process of recovery. Competitors Gap and Urban Outfitters have also been showing considerable strength.

Mar 3, 2014 at 11:02AM

The winter was not just bad for teen-fashion retailers... it was downright disastrous. On one hand, weather, among other industrywide factors, contributed to a sharp drop in mall traffic, eating into the top line. On the other hand, a brutal pricing war put enormous pressure on the bottom line, as retailers tried to out-discount each other throughout the period.

Now, it seems that the industry is recovering a bit, as Abercrombie & Fitch (NYSE:ANF) delivered a big earnings beat last week. Could the industry be turning around?

Changing channels
While the report was something of a mixed bag, it sent shares on a powerful relief rally of more than 11% on the day. Fourth-quarter earnings per share came in at $1.34, smashing the $1.05 consensus estimate. Full-year earnings also beat the Street, coming in at $1.91 versus a consensus of around $1.61. Clearly, the bottom line is doing better than feared over at Abercrombie & Fitch.

However, it was not all good news. For one thing, Q4 profit was down substantially year over year, sinking some 58%. Revenue missed expectations, sliding 12% to $1.3 billion and missing expectations of nearly $1.4 billion. Same-store sales didn't do much better, dipping 8% year over year.

In the report, management announced an accelerated share-buyback program of around $150 million for the first quarter. Looking further ahead, the company expects to earn between $2.15 and $2.35 per share for the full year on a high-single-digit decrease in same-store sales .

Faced with declining store traffic in its brick-and-mortar business, the company is now turning to other channels in order to prop up sales growth. It is increasingly focusing on its outlet stores, now making products specifically for this channel. Additionally, it is looking to expand its international business as sales slow in the U.S. Sixteen international stores are expected to open this year, while 70 U.S. locations will be shuttered.

In with the cool crowd?
A&F seems to be losing market share to competitors such as Urban Outfitters (NASDAQ:URBN) and a newly fashionable Gap (NYSE:GPS) and is perhaps no longer considered part of the cool crowd by teen consumers. The company's full-year and fourth-quarter results came in shy of Wall Street's expectations but still showed some decent growth, with holiday season sales up 8% year over year and net sales up 10% for the full year. The company's Free People business is still growing quickly; comp-retail net sales were up 20%.

Gap also looks good going into earnings. The resurgent retailer is expected to keep up its solid performance for the fourth quarter, having posted comp-store sales increases of 2%, 5%, and 1% for the first three fiscal quarters of the year, respectively. Gap has been successfully bucking the slump in U.S. fashion retail for some time now, in part due to its appealing product offerings and solid image. Fourth-quarter guidance of $0.65-$0.66 was considerably higher than the $0.60 consensus, and these will probably be the numbers to watch.

The bottom line
The teen-fashion retail industry is showing some signs of recovery after a dreadful winter, which lowered already-depressed levels of store traffic and a brutal discounting environment. Abercrombie & Fitch, while reporting lower earnings and revenue, easily beat analyst expectations, indicating that the current slump isn't as bad as feared. Still, the company is facing stiff competition from rivals such as Gap and Urban Outfitters and may have to struggle to regain its image with younger consumers.

Are fashion retailers a top pick for this year?
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Daniel James has no position in any stocks mentioned. The Motley Fool recommends Urban Outfitters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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